Renewable energies in the I-SEM: the 'Aggregator of Last Resort'
24 March 2015
Author: Conall Bolger, senior consultant, Gemserv
The wholesale electricity market is due to transform by the end of 2017. The new market, the Integrated Single Electricity Market (I-SEM), involves significant changes to the existing electricity market so as to bring the Irish market into compliance with the requirements of the European Target Model. The new energy-trading arrangements could dramatically alter the manner in which renewable generators interact with the market.
The market structure alters from a gross pool market with a capacity mechanism to an energy-only market with four categories of trading arrangements (a day-ahead market, an intraday market, a balancing market and an imbalance market) and a new capacity remuneration mechanism. It creates a new foundational principle, which is that generators become ‘balance responsible’: they are responsible for ensuring that generation matches demand. This structure may create a challenge for variable generators, especially wind farms.
The central risk is that these generators could be unable to adequately mitigate the balancing risk in the intraday and balancing markets. In this scenario, they could be required to participate in the imbalance market at potentially punitive rates. The Regulatory Authorities (RA) have proposed a mechanism which, in theory, should help address this issue, the Aggregator of Last Resort (AOLR).
I-SEM and the Aggregator of Last Resort
At a high level, the AOLR aggregates the output from multiple wind generators and participates across different trading arrangements on their behalf. The AOLR is not mandatory for participants. There is an intermediary arrangement in the current Single Electricity Market (SEM), whereby a wind generator contracts with a supplier for a power purchase agreement (PPA) and the supplier undertakes trades within the market. These existing arrangements are expected to persist in the I-SEM.
The AOLR can be envisaged as offering three broad services (see Figure 1): managing complexity, managing liability and managing market risk. The AOLR addresses market complexity through trading on behalf of participating generators and submitting nominations on their behalf to the transmission system operators (TSO). They can manage generator liabilities by assuming market responsibilities such as signing up to the Trading and Settlement Code (TSC). It manages risk through socialising the risks of individual generators failing across the entire portfolio. However, these functions will vary dependent on the model implemented.
The RAs proposed three potential models for implementation of the AOLR. They range on a continuum from a model where the AOLR is very active to one where the AOLR is more passive. These options are summarised below:
- Portfolio Settlement Aggregator – the generators are grouped into a single portfolio in which the AOLR acts on behalf of its participants. All of the functions discussed above are within the remit of the AOLR;
- Individual Settlement Aggregator – the generators are contained within a single portfolio. They are settled on an individual basis so that they can take consideration of generator instructions such as individual trading strategies. They undertake most of the functions above, except the risk pooling function;
- Passive Aggregator – the aggregator is more of a mechanistic market system than in the other models. The generators undertake responsibilities within the market such as signing up to the TSC. The AOLR pursues a more limited suite of functions.
The regulatory consultation upon these proposals concluded in January 2015. The next consultation is due in April 2015 with a decision on the AOLR Framework to follow in August of this year, according to the I-SEM Project Plan. The next section discusses some thoughts upon these proposals.
The AOLR is an innovative proposal that, depending on the AOLR Framework selected and on its manner of implementation, may have positive effects for the renewable-energy sector. The wider question is whether the AOLR could be a precursor to renewables within Ireland not being subsidised through a Renewable Energy Feed in Tariff (REFIT) or comparable policy.
I-SEM will provide the backdrop to achievement of the 2020 renewables targets, so it also raises a question as to the efficacy of such a model and whether it would be financeable within the market. These wider issues provide the context to the detailed regulatory proposals that are the focus of this article.
Within the RA’s consultation paper, there was a question as to which body should implement the AOLR: the regulator or the TSOs. The paper also considered a subsidiary issue of whether the TSO, if chosen to implement, should undertake the role of AOLR directly or should contract the role with a third party. Utilising a third-party service provider, selected via a competitive tender process operated by the TSO, may be the most advantageous approach.
In effect, the AOLR will be a market participant. It seems quite difficult for the regulator to balance its role of sitting outside the market-regulating trading activities with holding a stake in a direct participant. The TSO, with its experience of operating business separation protocols and measures, should be capable of engaging in an arm’s length arrangement with another entity such as an AOLR. As the credibility of the AOLR is likely to be linked to its perceived neutrality within the market, the greater the degree of separation, then the better it may be for the AOLR in terms of encouraging participation, legitimacy and credibility.
If selecting this approach, then thought will need to be given to how the contracting process might work. In order to encourage bidding for the AOLR service, the contract would need to be commercially advantageous for potential bidders. If tenderers were expected to take all downside risk, without being able to access upside risk, they may be discouraged from participating in the process. In such a setting, it may make sense for the contracting body to look at risk sharing and incentive structures. Such incentives could be linked not only to market revenues achieved, but to outcomes that the contracting body might desire, such as particular service levels within the contract delivery and mobilisation phase.
To gain the greatest benefits from the AOLR, a high level of participation from market participants will be required. As such participation is voluntary, they need reassurance that the mechanism is credible and cost beneficial. A high take-up would result in costs being spread across a broad suite of participants, reducing the cost per head and increasing efficiency. In addition, a third-party organisation is likely to have a high incentive to keep the costs associated with the AOLR down.
We would suggest that a degree of flexibility within the aggregator could be useful, particularly as the types of organisations that may use the service vary so much that a one-size-fits-all approach may prove ineffective. We would suggest there is an amalgam of the Portfolio Service Aggregator model and the Individual Settlement Aggregator, whereby wind participants could choose which portfolio their output is managed in, similarly to a person choosing a pension or investment fund.
In addition, as discussed in the RAs’ proposals, there would be value in permitting smaller non-wind participants into a portfolio under the AOLR. Having less variable generators included might help with the risk profile of the overall mechanism.
With the profound transformation in the electricity wholesale market as a result of the introduction of the I-SEM, renewable generators face a challenge in managing their balance and imbalance risk exposure in the market. While not mandatory, the AOLR mechanism may provide a useful platform for wind generators.
The final decisions on the AOLR Framework are due to be taken by August 2015. The AOLR should have a degree of flexibility built into its implementation and include different portfolios of AOLR participants – for example:
- A portfolio that aligns with the Portfolio Settlement Aggregator Model;
- A portfolio that aligns with the Individual Settlement Aggregator; and
- A portfolio for smaller non-wind participants.
The proposal for a third-party service provider to undertake the AOLR, contracted with the TSOs, may prove the most effective delivery model.
Conall Bolger is a senior consultant with Gemserv, leading on the provision of energy consultancy services in Northern Ireland and Ireland. He is the author of Developing I-SEM, a paper discussing the implications of the new wholesale electricity market. Conall can be contacted at firstname.lastname@example.org